Determinants (CEO) Remuneration

Determinants (CEO) Remuneration

Determinants (CEO) Remuneration

Introduction

CEO compensation is topical and controversial and accordingly receiving considerable attention by various stakeholders. We investigate whether rent extraction or labour demand explains CEO compensation level in PMC. We do so by examining the determinants (economic, governance and ownership) of CEO compensation level and explore the relationship between predicted excess compensation and subsequent firm performance. Our results suggest that governance and ownership attributes, in addition to economic attributes, are significant determinants of CEO compensation. However, these attributes differentially determine the various components of CEO compensation.

Discussion

In firms with dispersed ownership, the possibilities of (1) the CEO deriving non-pecuniary interests from their control of corporate resources, (2) differences in shareholder and management risk profiles and (3) conflict between decision-making time horizons, jeopardises the fundamental obligation of the CEO to act in the best interest of shareholders. Compensation agreements, incorporating pay for performance, are examples of ex ante monitoring costs designed to control such dysfunctional behaviour and maximise firm value (Milbourn, 1996). Jensen and Murphy (1990) propose that the incentive for CEOs to maximise firm value requires: CEOs having a substantial ownership stake in the firm; salaries, bonuses and stock options being structured so as to provide big rewards for superior performance; and substantial penalties (including a real threat of dismissal) for poor performance. Similar to international developments, PMC CEO compensation contracts have become more sophisticated with increased use of long term incentive rewards (options and shares) and more contingent pay.

Incentive implications of the various components differ. Increasing accounting profit is the incentive provided by bonus plans, whereas share and option rewards are designed to encourage maximising shareholder returns via share price appreciation.6 The heterogeneity of CEO compensation contracts has spawned considerable research on the determinants of the nature and structure of such contracts with cross sectional differences in CEO compensation attributed to firms' economic, governance and ownership attributes (e.g., Smith and Watts, 1992; Gaver and Gaver, 1995; Holthausen, Larcker and Sloan 1995; Lambert, Larcker and Weigelt 1993). Consistent with Core et al.'s (1999) theoretical framework, the null hypothesis investigated in this study is that, after controlling for economic attributes, governance and ownership attributes induce optimal CEO compensation contracting. Accordingly we expect the CEO compensation level to be associated only with firms' economic attributes reflecting the demand for labour.

Economic determinants of compensation

Reflecting demand for labour, economic attributes positively associated with CEO compensation include firm size, risk, performance and growth opportunities (Rosen, 1982; Smith and Watts, 1992; Banker and Datar, 1989; Milkovich and Rabin, 1991; Elloumi and Gueyie, 2001). The operational complexity of larger firms and managing firms with growth opportunities and riskier operations, demands higher quality executives with a corresponding higher compensation demand. The literature documenting evidence on the magnitude of the relation between compensation and past firm performance is mixed and ongoing. Early studies determined a weak relation (Jensen and Murphy, 1990), however this relation has subsequently shown to be more substantial (Hall and Liebman, ...